Are Personal Injury Settlements Taxable in New York?
After suffering an injury due to someone else’s negligence, obtaining a personal injury settlement can provide important financial relief to cover medical expenses, lost wages, and other costs related to your recovery. However, many injury victims in Queens wonder: are personal injury settlements taxable? This is a valid concern, as no one wants to be surprised with unexpected tax obligations after finally receiving their compensation.
The good news is that most personal injury settlements are not taxable under federal law. However, there are important exceptions you should understand before accepting any settlement. At The Tadchiev Law Firm, P.C., our personal injury lawyers ensure our Queens clients know what to expect when they receive a settlement.
Non-Taxable Damages in Personal Injury Settlements
When people ask, “Is a personal injury settlement taxable?” the answer is generally no, as long as the compensation is related to physical injuries or physical illnesses. According to Section 104(a)(2) of the United States Internal Revenue Code, damages received for physical injuries or physical illnesses are specifically excluded from taxable gross income.
This tax exclusion covers several types of compensation related to physical injuries, including the following:
Medical Expenses
All compensation you receive for past, present, and future medical expenses related to your physical injury is not taxable. This includes hospital bills, surgeries, prescription medications, physical therapy, chiropractic care, medical equipment, and any other treatment necessary for your recovery, including projected future costs.
Lost Wages
Compensation for lost income due to your physical injuries is generally not taxable when it’s part of a personal injury settlement. This includes wages you lost while recovering from your injuries, as well as future lost earning capacity if your injuries prevent you from returning to your previous occupation or working at the same level as before the accident. Even though you would have paid taxes on these wages had you earned them through normal employment, when they’re paid as part of a physical injury settlement, they’re not subject to taxation.
Physical Pain and Suffering
Damages awarded for physical pain and suffering are not taxable. This includes compensation for the physical pain you experienced as a result of your injuries, ongoing discomfort during your recovery, and any chronic pain that may continue in the future. Because these damages compensate you for physical injuries, they fall under the tax exemption.
Emotional Distress Related to Physical Injuries
If you developed emotional distress, anxiety, depression, or post-traumatic stress disorder as a direct result of your physical injuries, compensation for that emotional distress is also not taxable. The key is that the emotional distress must originate from the physical injury itself. For example, if you suffered broken bones in a car accident and subsequently developed depression due to your physical limitations and pain, that emotional distress compensation would not be taxable.
Taxable Damages in Personal Injury Settlements
Although most personal injury settlements are not taxable, there are important exceptions where portions of your compensation may be subject to federal taxes. They include the following:
Punitive Damages
Punitive damages are always taxable, even when they are part of a physical injury case. Unlike compensatory damages that seek to reimburse you for actual losses, punitive damages are awarded to punish the defendant for particularly reckless, malicious, or intentional conduct. The IRS considers these damages taxable income regardless of the type of case or the nature of your injuries.
Interest on the Settlement
Any interest that accumulates on your personal injury settlement is taxable as ordinary income. If your case takes months or years to resolve and interest accumulates on the settlement or verdict amount from the judgment date until payment, that interest portion must be reported as taxable income on your tax return. The settlement principal remains tax-free, but the interest does not receive the same exemption.
Emotional Distress Without Underlying Physical Injury
If you receive compensation for emotional distress or mental anguish that does not originate from a physical injury or physical illness, that compensation is generally taxable. It’s important to distinguish between emotional distress caused by physical injuries (not taxable) and emotional distress without underlying physical injury (taxable).
Previous Medical Deductions
If you deducted medical expenses related to your injury on prior years’ tax returns and then receive a settlement that reimburses those same expenses, you may owe taxes on that portion of the settlement up to the amount of your previous deduction. This is because you already received a tax benefit for those medical expenses, and the IRS does not allow a double tax benefit.
State Taxes on a Personal Injury Settlement in New York
Many of our clients in Queens specifically ask us: “Are personal injury settlements taxable in New York?” Fortunately, New York generally follows federal rules regarding taxation of personal injury settlements, which means more good news for injury victims. If your settlement is not subject to federal taxes under Section 104(a)(2) of the Internal Revenue Code, it will also not be subject to New York state taxes.
How a Personal Injury Attorney Can Help Maximize Your Compensation
Understanding the tax implications of your settlement is only one part of maximizing your total recovery. An experienced personal injury attorney can help you in several important ways to ensure you obtain the full compensation you deserve and retain as much of that compensation as possible.
For example, the way your personal injury settlement is drafted and structured can have significant tax implications. Experienced injury lawyers understand the importance of carefully structuring settlements to minimize tax obligations. Your settlement agreement should clearly specify which portions of compensation are for physical injuries, medical expenses, lost wages, pain and suffering, and whether taxable components such as punitive damages are included.
This detailed specification helps determine what is taxable and what is not. If the settlement does not clearly specify how funds should be allocated, the IRS can make its own determinations, which could result in unfavorable tax consequences.
During settlement negotiations, your attorney can work to structure the settlement in a way that favors non-taxable components. For example, if both compensatory and punitive damages are being considered, your attorney can negotiate to increase compensatory damages (not taxable) while potentially accepting lower punitive damages (taxable), resulting in a higher net recovery after taxes.
Get in Touch with Our Queens Personal Injury Lawyers for Help with Your Case
If you have been injured due to another person’s negligence in Queens or anywhere else in New York City, don’t face the legal process alone. The tax implications of personal injury settlements are just one of many complex aspects of these cases that require professional legal expertise.
Contact The Tadchiev Law Firm, P.C. today to schedule your free, no-obligation consultation with our experienced Queens personal injury attorneys.
About the Author
Simon Landsberg
Simon B. Landsberg is an associate attorney at The Tadchiev Law Firm, P.C. He focuses his practice exclusively on representing individuals and families who have been injured in motor vehicle accidents and due to other forms of negligence.